Setting the Record Straight: Three Exit Strategy Myths

Have you heard “timing is everything?” It’s tough to make money these days. Times are different as compared to 5 or 10 years ago. The fact is the economy is slower, immigration reform is a battle, fuel costs, taxes, Obama-care and pricing competition are all keeping companies guessing and on their toes. So what’s your plan? Do you have an exit strategy? How about an operating strategy that coordinates with your exit plan? Are better days ahead after November?  Take control and start planning.

The bottom line is, in today’s economy, you have to be a smarter owner, with better people and better processes. Success requires thinking outside the box and takes planning with the right team of advisors. You need people who challenge you, not just “yes” men who charge a fee. Too may advisors are saying you are ready now and telling you there a tons of buyers in the space. We don’t see it that way. You have missed vacations, school events and ballgames. You work long hours and fight fires daily, but the sacrifices are worth it because you have built a great business. Negative factors and risk surround this industry. So where are you headed? How and when do you cash in your chips?  You only get one shot at your exit.  Get it right!

Let’s start by sifting through all the advice from CPA’s attorneys, consultants, business brokers, and of course my favorite, the former business owners who are now suddenly experts in the deal game. Let’s set the record straight and help you avoid making mistakes. No sugar coating or sales pitch here, just facts from the trenches.

Myth #1: Private Equity is a real option for most sellers:

 First, let’s be clear here. Our industry is full of companies backed or 100% owned by private equity firms. There are great success stories here, there’s no disputing that. However, most PE firms, (i.e. those not already operating in the industry as competitors and buyers), are really only interested in companies that drive $2.0-$3.0 million in adjusted EBITDA (earnings before interest, taxes, depreciation, amortization and add-backs). The revenue base must be reoccurring, typically with commercial maintenance contracts or turf care service.  Size and scale-ability are important and so is a strong and deep management team. Let’s be realistic though, most landscaping companies don’t fit that size and earnings profile.  There are probably better options available than PE hope. Beware of all the talk that private equity is such a great option and readily available. Know who you are and what options are really in play for your company.

Second, private equity buyers purchase “controlling interest”. Thus selling anything less than 100% of your company (51% or more) means you don’t call the shots anymore. You may be able to make some day to day decisions but if push comes to shove or the business is not performing, you’re the guy who gets kicked to the curb! How would that feel?  Deal structure and documentation are negotiable but key here. While this strategy is not impossible to make work, there needs to be unique circumstances, agreements and a real common vision and business model to make this work. It is interesting to us that this gets so much press and discussion in our industry. Know the game. 

Myth # 2 Your Company is worth 1x revenue or 5x your earnings:

Understand this, earnings or free cash drives the value of your organization not revenue.

The more profitable a company is the more valuable it is period. Historical performance of more than 12 months becomes less important in an analysis of value. Given uncertain market conditions, a look at a company’s trailing twelve month performance becomes important. How are you trending? Are you on budget for your 2012 plan?  The  goal  of reporting strong earnings is often counter to what companies do for tax planning purposes, i.e. showing as little profit as possible. We support not paying more taxes than necessary, but this becomes a balancing act equation and thus it is important to coordinate a profit plan with tax planning and with the timing an of an exit. Be sure to be diligent in recasting financial performance to include add-backs, depreciation, and interest.  An updated valuation should become standard practice in an organization following close-out of a company’s fiscal year.

Next, don’t discount or ignore the importance of your company’s value drivers or value detractors. Is your company marketable? Revenue ruling 59-60 defines value as:

“the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.” 

Translation…. It’s worth something only if someone will write you a check! So what factors are important and how does it affect your multiple?

Consider these factors carefully and have an execution plan: (1) intangible value such as goodwill and reoccurring revenue accounts (2) financial ability to generate an ongoing profit stream; (3) Condition of equipment and fleet; (4) type of business and its financial and market history; (5) economic outlook for the industry in which the business resides; (6) stability of work force and structure of the management team (7) Strength of a company’s balance sheet; (8) Strong financial reporting and operating systems.

Myth # 3:  The amount of Purchase price determines whether a deal gets done:

 Each deal is unique. In every transaction there are motivating factors for sellers and buyers. Owners have to have specific answers to the following questions:  (1) What are your goals? (2) Have you quantified them? (3)What’s your timeline? (4)What’s the market bearing? (5)What are the tax consequences?  (6) Is your company built and positioned to be marketable?  (7) If you keep operating the way you are now, what impact will time have on your value? (8) What risks exist in my industry and business?

A good exit strategy is often time executed and planned over a 24 month time period. Market conditions are having an impact on deal structure. Deal structure means how and when someone gets their money. We say structure kills more deals than purchase price or valuation. Purchase price can include or exclude balance sheet adjustments (debt, and working capital), some can require owner financing, can include/exclude real estate and lastly could involve employments agreements and non competition arrangements.  Often times there are earn-outs or pay-outs tied to profit or revenue. Getting paid 100% cash deals at closing are rare. This is due to economic conditions, pricing and competition. That being said it is negotiable and each deal is unique.

Your deal and deal structure will only be as good as the team who negotiates it. Beware, as the industry is full of pretenders. If an advisory team has not closed more than 12 deals in the green industry then keep looking. Do you want a heart surgeon who is performing his first surgery? Same principles apply here. Get going! Make sure your operating plan coordinates with your exit strategy. Get it done!